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Are ETFs a Blessing and a Curse for Yield-Seekers?

Andrew Gogerty

Andrew Gogerty: Hi. This is Andrew Gogerty, coming to you from the Morningstar ETF Invest Conference. We are talking today about fixed income. The S&P 500 is up double digits this year, but one of the bigger trends in the ETF market is the growing depth and breadth of ETFs available to investors. And joining me today for perspective on this current trend is Mitch Reiner, managing partner from Wela Strategies.

Mitch, thanks for joining me today.

Reiner: Thanks for having me.

Gogerty: So, we have the fiscal situation, but yet the S&P is still up double digits this year. EAFE emerging-markets stocks are still up double digits, and lot of people are moving back to U.S. equities, at least in the ETF-managed portfolios space. What are some of the key drivers inside fixed income? It's not growing, but it's still there and still a core part of lot of portfolios. What are those themes this year?

Reiner: I'd say, more than anything, it's the hunger for yield. You can't find yield out there. It's either people who have been sitting in cash because they are risk-averse for a long time and now they need some yield. So they are begging; they are saying, "I am tired of earning zero." The folks that have been buying certificates of deposit four or five years ago and had 4.5% yields, they're not getting those anymore. Those are rolling out $100,000, $200,000 lots. Where do I put that money? So I think that is the big desire and drive for yield is that the baby boomers are now having some cash that they are tired of earning zero on and what Bernanke has been doing is working there. He has getting people to take a little bit more risk.

Gogerty: One of things about risk, and it's a different risk than what we had today or even a few years ago, is the fixed-income ETF market is changing. You are getting more rollouts; you are getting access to parts of the world that even frankly on the individual security side were so expensive to go to. But now you're getting it in a cost-efficient way. What is that mean for fixed-income investing going forward? Does it change it, or does it just simply give you a bigger toolbox?

Reiner: Definitely as a strategist, it gives us a bigger toolbox, and I think that it is necessary. And it's great for us to have that availability. I mean how else were we able to gain that kind of exposure in the past? Buying individual bonds is just an inefficient process. With these fixed-income ETFs, it's much more efficient.

However, the problem is now its creating a more choice and more ETFs, and it's already in an abundant environment that I think for the retail investor it's difficult to grasp, "Where should I go; where should I put my money?" And I think that that is going to continue encouraging the need for strategists to bundle those together. I think it's great; it keep costs low. It allows the individual retail investor to get access to strategists like us who keep cost low with ETFs, but at the same time, it complicates things because there are so many now. I mean when you slice the high-yield market up into seven different tranches, you're going to confuse the retail investor and they may invest in the wrong area that they may want to be investing in.

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Gogerty: So, it seems like even for the strategist, for the professional investor with a strategy, they have to almost rethink what a fixed-income strategy means because there may be more inputs in asset classes that they didn't have before. How does that impact the market?

Reiner: Every day. I mean every day there's new questions that we're asking, "How can we make it better, and how can we change it with the new additions that are out there?" As soon as we can confirm liquidity and certain other issues that are a concern for us, it is an exciting world to be in because we can gain unique exposures and take advantage of market movements when they present themselves.

Gogerty: You talk about new opportunities. One of the new strategies Wela has is an Agg Yield strategy, which has a sleeve of fixed-income ETFs along with other asset classes. What are some of the key things or exposures that you're expressing this year that are showing up attractive in your investment process?

Reiner: Sure. So, what I'll start and say that, for example, with the whole QE3 deal, longer-duration bonds within our fixed-income sleeve is something we're tilting toward right now. On the high-yield side, the spreads started coming in. Even though you look at your spreads--and I don't know how relevant they are when real interest rates are negative--but in reality still they've come in so much that we're saying, "Maybe now is the time if there is a global slowdown on the horizon to go a little bit more on the higher credit quality and less junkier side."

So, we've shifted our allocation to high-yield bonds a little bit; A, away from an ETF that was junkier than the other one; and B, a little bit away from that allocation. And I think you also can take advantage on our other two sleeves, one of which being is closed-end funds, and you can benefit from leverage. Interest rates are now low. They are likely to stay low on the short end of the curve. So, you can benefit from a little bit of leverage. I know that's a scary word now, but benefit from that by borrowing low and lending long at a higher rate. So, I think those types of decisions and what happens with interest rates and the bond market in general, shift the way that we allocate the Agg Yield portfolio.

Gogerty: How about looking at the Barclays Agg as an index, when the government came in, it really took like four asset classes down to two with that backstop. Are you seeing a separation or is buying the U.S. market, with the exception of high-yield, still just buying the government? How are you seeing that correlation, and does it make sense to look at those individual asset classes in the U.S. right now?

Reiner: So, what I would say is that absolutely by taking everything that used to be AAA quality and taking that number of assets down, yeah, you are limited on the government side, and it really has become more of a duration game than an international versus domestic game. And also on the credit side, investment-grade credit is so hot right now, if you're an individual bond buyer trying to find a bond when it's newly issued, it's impossible unless you're making a $100 million order or more. So, what I am saying is, yes, they've limited it and created more demand for the other asset classes, which gives us an advantage of knowing that maybe those asset classes are where our clients' money needs to be within Agg Yield.

Gogerty: Great. Thank you for your perspective today and your time at the conference. I appreciate it.

Reiner: Thanks, Andy.

Gogerty: This has been Andrew Gogerty with Mitch Reiner from Wela Strategies at the Morningstar ETF Invest Conference. For more information on ETF managed portfolios, please check out our ETF Managed Portfolio Center on Thank you.